Put your money where robust long-term growth is

Leon Kok

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The case for South Africans exposing
themselves to a leading dollar-denominated emerging markets (EM) fund is a
no-brainer. EM’s role in driving global growth should not be underestimated,
either including or excluding China. EM ex-China accounted for 32% of 2017 real
global growth in US-dollar terms, while China alone amounted to an additional
27%. By comparison the US contribution was 16%.

Launched in February 1991, the US-dollar
denominated $965m Templeton Emerging Markets Fund has returned a cumulative 279%
in US dollars since then, and 31% over the last three years.

This fund is managed by Chetan Sehgal,
senior managing director and director of portfolio management, Franklin
Templeton Emerging Markets Equity, and overseen by Manraj Sekhon, chief
investment officer of Franklin Templeton EM Equity. While the team’s philosophy
is value-oriented, the investment style is core, involving buying shares of
companies with sustainable earnings power that trade at a discount to intrinsic
value. The team generally aims to generate returns commensurate with the
double-digit earnings growth typically seen in emerging markets, and alpha of
2% to 3% per annum over a rolling three-year period.

An important feature of the Templeton EM
Fund is its global spread and broad diversification. From a geographic
perspective it is linked to the MSCI EM Index with its main components
comprising China 24% of the total (compared with MSCI Index’s 31%), South Korea
18% (14%), Taiwan 11% (12%), SA 8% (7%), Russia 7% (4%), India 7% (9%), Brazil
6% (6%) and Thailand 3% (2%).

The primary themes within the portfolio are
concerned with the growth of technology and innovation, as well as rising
consumer penetration and ‘premiumisation’ of consumer demand (not just buying
cars, but buying BMWs, for example). These sectors and companies offer
diversification to South African investors given the dominance of financials
and materials in the domestic economy.

While country and sector bets are limited,
the fund relies on stock selection to generate returns – hence here the
differences with the index are more evident, with a large number of non-index
exposures. The five biggest holdings are Samsung Electronics 8%, Naspers* 7%,
Taiwan Semiconductor Manufacturing 6%, Alibaba 4.6% and Brilliance China
Automotive Holdings 3.5%.

Sehgal concedes that EMs suffered a setback
in the first half of this year and that the impact of trade concerns, a
strengthening US dollar and high volatility in markets such as Argentina and
Turkey has been more profound than expected, but they discount the possibility
of a wholesale derailment in EM fundamentals.

The sharp market gyrations (mainly
downwards) in EM equities and currencies, in their view, have generally priced
in scenarios worse than is likely to be the case.

If you look at EMs in general, most are in
good shape with good earnings growth and better growth prospects than developed
markets in the years ahead, they say.

Moreover, most EM currencies have floating
foreign exchange regimes and as a group run a current account surplus. The
effect furthermore of the strong US dollar will differ from country to country,
depending on each nation’s economic structure and policies.

Nor does Sehgal maintain that a slight
slowdown in China will bring downside risks for other EM markets. On the
contrary, he argues, the quality of growth should continue to improve as the
government takes up efforts to reduce financial stability risks and rebalance
the economy. China’s efforts to rebalance by way of slowing investment growth
are a positive development for the rest of the world.

Naturally, of course, there will always be
risks too. The value of an EM portfolio and resultant yields can especially
fall or increase due to changes in markets. This can result in the unit value
falling below the amount you originally invested and obstruct you from reaching
your investment goals.

So why consider this fund?

Franklin Templeton has been a pioneer in EM
investment. It introduced the industry’s first closed-end fund dedicated solely
to EMs in 1987.

The group keeps an active presence in local
markets with a team of over 70 dedicated portfolio managers and analysts
located across 18 offices around the world, maintaining a first-hand
understanding of the economic trends of their respective regions.

The fund managers invest with a long-term
view in EM companies it believes are under-valued relative to the
sustainability of their earnings, fundamentally strong, growing, and capable of
weathering difficult times.

This year’s slide in EM stocks has made
them relatively cheap judged by the MSCI EM Index on around 11.2 times this
year’s earnings, down from 13.3 times earlier this year and now hovering at
their lowest in more than two years. The discount compared to developed markets
(MSCI World) has widened considerably.

EMs have consistently proven their return
potential and there is little reason to believe that this will not continue in
the longer term.

*finweek is a publication of Media24, a subsidiary of Naspers.

This article originally appeared in the Fund Focus supplement in the 13
September edition of finweek. Buy
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